6 Reasons Housing Will Still Go Down

"The crisis cannot end fully until home prices in the U.S. are at least stabilizing."

Alan Greenspan, Former Fed Chairman

Housing is the number-one investment by the majority of Americans. It financed, through equity withdrawal, the last boom market. As Mr. Greenspan pointed out, there can’t be a true revival in the economy until the people’s number-one asset stops dropping in value.

Here are six reasons why that won’t happen soon.

Reason 1: There Is No Demand

Year over year, new home sales fell 32.8%. And the price of those houses continues to fall. The median sale price of new houses sold in May 2009 was $221,600 – down 3.4% from a year ago.

May is the most recent number for new home sales. The bulls would make the argument that sales are stabilizing. They are wrong. You could make an argument that you’d buy a new house with a cheaper monthly payment based on low mortgage rates. But that’s changed since in the past month. Now you have both falling housing prices and rising rates.

Reason 2: Since May, Mortgage Rates Have Gone Up…

According to Greg McBride, the senior financial analyst at Bankrate.com, it’s unlikely we’ll see mortgage rates below 5% in this cycle. This is because the yield on the 10-year note, which most heavily influences mortgage rates, is going up. It’s going up because the U.S. government must sell debt to finance its $12.8 trillion in stimulus, bailouts, backstops and B.S.

According to Bloomberg, “the yield rose 0.06 percentage point to 3.7 percent after the Fed kept the size of its $1.75 trillion bond-purchase programs unchanged, failing to ease concern that record government borrowing may lead to higher interest rates.”

It is no wonder that the Mortgage Bankers Association cut its projection of mortgage volume this year by 27% to $2.03 trillion.

The group said “its estimate is well less than the one it made only three months ago because the government's residential-refinancing program has not taken off as expected and then interest rates started heading up.”

You can’t buy a house if you can’t afford the payment. Expect the June housing sales numbers to be lower again.

Reason 3: Too Much Supply

The biggest problem with post-bubble housing is too much supply. Three or four years ago, used homes were selling at an annual pace of 7 million units, with fewer than 3 million up for sale in any given month.

Today existing-home sales have fallen to less than 5 million with 4 million on the market at any given month. And the average time a house sits on the market has grown from three months to 10.2 months.

Reason 4: Option ARM – The Next Wave of Default

Back in 2005 to 2007, you could pick up a mortgage in which you paid only interest and no equity. The bet was you could refinance (after the value of your house went up, of course) before the reset date hit and you had to start making full payment.

The bad news is the bet didn’t work. Over the next two years you will have a wave of borrowers who must start making full housing payments – sometimes 50% more than what they are making now. Many, if not most, will owe more than their house is worth and will likely just walk away.

Reason 5: Jobless Claims Are Going Up…

On Friday the Labor Department said that jobless claims rose by 15,000 to 627,000 in the week ending June 20.

As I said about two weeks ago, when jobless claims fell “unexpectedly,” you should expect future numbers to rise. This is because the jobless claims from the automakers had yet to hit the government’s statistics.

If you count all the upstream parts makers and downstream dealers, those without jobs will add up to more than 700,000. That’s on top of the number of people collecting unemployment insurance, which also climbed this week by 29,000 to 6.74 million.

According to Bloomberg, the Federal Reserve is looking at the half-full glass of the economy by saying the slump is “slowing.” But the reality is that more job losses is more job losses, deceleration or not.

And people who don’t have a paycheck can’t get a mortgage. At least not anymore…

Reason 6: Market Psychology

Bubbles don’t reflate until the next generation of suckers...

If you take a historic look at investment bubbles, you will notice that prices in bubble assets, be it tulips or Microsoft (MSFT), never return to their highs in a generation. You can’t burn the same people twice on the same product.

Remember when Microsoft, Disney (DIS) and Wal-Mart (WMT) were the “must-have” stocks to own? Have you looked at their ten-year charts?

The very nature of a bubble is that at some point everyone who is going to buy, buys. Then it pops. There is no one else to drive it higher. No greater fool.

The same will be true in real estate. At the top, more than 68% of families in the U.S. owned houses. Every one of them saw the value of their house plummet, at least on paper. Right now you have speculators on the sidelines waiting to buy housing on the cheap. They aren’t wading in because they don’t want to catch a falling knife. Many will play the inevitable sucker's rally.

But over the long term, market psychology is such that at the bottom four false rallies down the pipe from now, the common wisdom on Main Street will be that “it’s better to rent than it is to own.” When you start hearing that from your barber or taxi driver, you’ll know it’s time to start buying.

Disclosure: No positions

Comments

[Joe Adamaitis]

You forgot one of the more critical points which is related to the lenders and government as it relates to new regulations and tighter lending guidelines which are making it harder to purchase, or refinance. Since the new regulations (announced in May) and include the new HVC (for appraisals) and HERA and HOEPA, the government has basically put enough pressure on those non-bank lenders to close up and thereby reduce competition.

Tighter guidelines and new regs have increased costs to borrowers and lenders. As the non-banks slowly disappear you will have what we all knew was coming.......national lenders who will be the only game in town and who will dictate what the rates are and who they will lend to. Meaning: tighter lender guidelines and options than you have today. As for refinancing which could certainly help, the new programs from Obama have done little.

The fact that Fannie and Freddie have chosen two different sets of guidelines makes it complicated for both lenders and borrowers. The fact that they have been slow to react to the criticism is even more frustrating and lastly their automated systems continue to kick qualified borrowers out at the end of the process infuriating borrowers who have spent the new increased fees upfront which are tied to the new HVC (Home Valuation Code...Thank you Mr. Cuomo).

To conclude and make matters worse, the loan modification programs are failing at an alarming rate as lenders continue to hold back from principal reduction. While the number of homes in foreclosure from what I understand has slowed, everyone is bracing for an enormous new wave as you mentioned due to the Pay Option Arms. However, this number will continue to rise well into 2010 as unemployment continues to rise and we see more and more prime loans hit the foreclosure lines.

Not that I am some type of rocket scientist, but wouldn’t it be better to arrange a true modification with principal reduction combined with a lower rate to keep that borrower in the house? I would much prefer to see that borrower remain than put another house on the foreclosure train.

Yes, six reasons plus, plus!

2009 Jun 28 09:18 AM

[Joe Adamaitis]

You forgot one of the more critical points which is related to the lenders and government as it relates to new regulations and tighter lending guidelines which are making it harder to purchase, or refinance. Since the new regulations (announced in May) and include the new HVC (for appraisals) and HERA and HOEPA, the government has basically put enough pressure on those non-bank lenders to close up and thereby reduce competition.

Tighter guidelines and new regs have increased costs to borrowers and lenders. As the non-banks slowly disappear you will have what we all knew was coming.......national lenders who will be the only game in town and who will dictate what the rates are and who they will lend to. Meaning: tighter lender guidelines and options than you have today. As for refinancing which could certainly help, the new programs from Obama have done little.

The fact that Fannie and Freddie have chosen two different sets of guidelines makes it complicated for both lenders and borrowers. The fact that they have been slow to react to the criticism is even more frustrating and lastly their automated systems continue to kick qualified borrowers out at the end of the process infuriating borrowers who have spent the new increased fees upfront which are tied to the new HVC (Home Valuation Code...Thank you Mr. Cuomo).

To conclude and make matters worse, the loan modification programs are failing at an alarming rate as lenders continue to hold back from principal reduction. While the number of homes in foreclosure from what I understand has slowed, everyone is bracing for an enormous new wave as you mentioned due to the Pay Option Arms. However, this number will continue to rise well into 2010 as unemployment continues to rise and we see more and more prime loans hit the foreclosure lines.

Not that I am some type of rocket scientist, but wouldn’t it be better to arrange a true modification with principal reduction combined with a lower rate to keep that borrower in the house? I would much prefer to see that borrower remain than put another house on the foreclosure train.

Yes, six reasons plus, plus!

2009 Jun 28 09:19 AM

[Aryamehr]

Another important factor you fail to mention is "Stated Loans," without Stated loans many normally qualified willing buyers would not be able to purchase their desired homes. In a normal economy, before the real estate Ponzi scheme, fostered by the Federal Reserve and many of its large chartered members, stated loans were a standard staple of the industry, albeit with different standards requiring substantially larger downpayments and higher mortgage rates. Now that they are practically non-existant a large segment of the market has essentially been neutered. The funds that facilited these stated loans have completely dried up or been pulverized by the recent calamity in the financial markets. The problem with Stated loans was the qualification bar was irresponsibly lowered, where almost anyone with two legs and two arms could have qualified. Had the Investment community involved in the Secondary markets continued to demand the same historical prudent banking standards in underwriting these types of loans we could have most probably avoided the precipitous declines in real estate values, however that was not to be. Now that these results have completely decimated the traditional investors that catered to this Stated market, it will be hard to see any virtical adjustments in Real Estate until Stated Loans once again become part and parcel of the 'menu de fare' of lenders, regardless of minor movements in mortgage rates.

On another note, the Bush Administration and not the Republican Party, should take responsibility for the greatest Ponzi Scheme in history. A fake economy whose underlying base were inflated assets manifesting unsustainable growth and a population of economic junkies that became innured to easy money without any substantive work ethics. The problem with this was that it was so pervasive it spread like a virus to encapusule the entire globe, leaving no nation in its path as unaffected.

In conclusion, without massive inflation I do not see real estate values returning to their highs for at least another decade.

2009 Jun 28 04:03 PM

[Mad Hedge Fund Trader]

Reality can be such a bitch! Since I have been pelted daily with predictions that residential real estate has bottomed for the last 18 months, like hail in a Midwestern summer thunderstorm, I feel a public duty to tell you that is just not the case. Now that the state and federal moratoriums are off, foreclosures are accelerating. There are over a million Option ARM and Alt-A loan resets about to hit the fan. Since many owners will not see positive equity in their homes in their lifetimes, banks are seeing more walk always. The run up in mortgage rates from 4.5% to 5.5% has yet to hit the market. Some 18 million homeowners divert 50% of their incomes to pay for housing, double the 25% that is considered healthy, and many of them are losing jobs. While the volume of units sold has rebounded, the action is dominated by speculators, flippers, and bottom feeders bidding for properties at 10-40 cents on the dollar, not exactly a sign of health. Call me when Ozzie & Harriet Nelson come back to the market. I listen to industry insiders call the bottom of the Japanese real estate market for 15 years, until they finally died, and the market is still a fraction of its 1990 high. I thing we are closer to the bottom than the top in terms of price, but closer to the top than the bottom in terms of time. You can take that to the bank.

2009 Jun 28 04:04 PM

[Fred W]

Incomes cannot support the housing market without home prices returning to mid 1990s #s--about another 30% off today's "stabilized" market.
If you run the rent vs. buy #s, the cost of ownership and risk of continued price erosion makes renting the best choice for many people.

2009 Jun 28 06:10 PM

[mrlucky2day]

I have to disagree with the author on several points. i am a 30 year real estate veteran and I can tell you I have seen this movie before, granted not as bad, but the same boom and bust thing.

1) The publics "demand" for their own home is absolutely there, you ask most people about how they value home ownership and you will find it is "most" peoples dream.

2.) Although mortgage rates have gone up from historical lows, they are still very low in comparison to the normal rate over the last 30 years which has hovered in the 7-8% area, So it's not interest rates, but it's the government interference giving the public the idea that rates will come down and that may not happen as it is hard to have rates come down when you have the government borrowing "historic" amounts of money.

3) Regarding oversupply, yes there are a lot of houses on the market, but that can be absorbed quickly once the "public" believes that prices have stopped falling and this is done through the media, when the media starts saying it's alright to step back in the market, people will come out and buy. The main problem here is "perception", articles like the one written by the author are the very reason that perception by the public remains skeptical. Just like the stock market, the real estate market has over corrected. It is said, that housing prices have fallen to 2003 levels which says that the last five years growth didn't happen. This is floored logic because the average annual real estate appreciation over the last 40 years as averaged 3-5% per year which includes all the ups and downs, booms and busts over that time period, therefor, taking the least historic appreciation amount of just 3%, you would have the current real estate prices 15% higher than the current headline numbers you hear thrown around. Part of the reason is that the media focus on "the case-shiller report which in my opinion is flawed because it compares single family housing to rental rates and thus make there values based on those numbers,

4) Regarding Option Arms - This again has been an over hyped number. The fact is that many of the holders of option arms have already refinanced.

5) Jobless claims - They are lagging indicators and take longer to level out, have very little effect on current market conditions. Granted the fear of the public for their own jobs can delay making major purchases.

6) Market Psychology - Housing markets, like stock markets recover once the public believes that things are alright. In Real Estate markets, it is usually the government that will create an incentive for the public to buy as they did in the 1970's when they offered a good "tax credit" if someone, anyone, bought a home. This along with other incentives helped clear up the housing glut.
Today, the government is missing the mark completely. They have offered a "tax credit" only for 1st time buyers instead of offering anyone who buys a home a tax credit. Also, they have allowed the banks that we have financed to tighten credit standards so much, that only people with high credit scores can get the 5-5.5% rates which leaves out about 50% of the potential buyers.

The real solution to the real estate market troubles is as follows:

1) The Government Offers all buyers a $15,000 tax credit to buy a home. This would be far far cheaper than what the government is now spending of "our money" to fix the problem. I predict the glut would be cleared up within 1 year.

2) Allow local appraisers that know the market be allowed to value the real estate in their markets rather than allow outside firms who use faulty computer models as they are doing now. The latter has caused very low appraisals which have caused "contracts" to fall out, the opposite effect to what we want to happen. Real Estate is local and can not be valued from in front of a computer screen 3,000 miles away from the property.

3) The banks must be forced to have "reasonable" lending standards but not look for ways to simply get higher rates by putting most people in a lower score tier than they really belong. This is done by simply moving up their score requirements for the best rates, instead, they should use traditional underwriting methods like requiring the applicant have a job, be within debt ratios and have a sufficient down payment ie: 20%. Using these guidelines is why real estate loans for 100 years have been very good investments with extremely low default rates.

2009 Jun 29 10:54 AM

[joof]

Author is a general fighting the last war - the bust. California is now in a mini boom, and inventory has rapidly been depleted over that past 3-4 months. Prices are rising and bidding wars have become common in better locations . This because housing in CA is more affordable ( now that we are back to 2001-03 nominal values) than at any time in the last generation, there is pent up demand due to low home ownership rates, it is now often cheaper to own than rent and people want to live in their own place, not some landlord's.

There are signs that AZ and even NV have picked up

No one knows if it will continue past this season, but the assumption that it is straight line down to 1996 nominal values doesn't seem to be working out well for the hold outs

2009 Jun 29 05:15 PM